Use access key #2 to skip to page content.

The Pig in the Python, Bill Gross on the U.S. Credit Rating



June 17, 2009 – Comments (6)

One of the key metrics that the ratings agencies, HAHAHAHAHA oh excuse me, focus on when assigning credit ratings to countries is the ratio of a country's debt to its GDP.  As you can seen, as of the end of 2008 the United States actually was in surprisingly good shape when looking at this metric relative to other countries...particularly Japan.

The problem is people are looking at the amount of money that the U.S. government is spending and what the potential economic growth in the U.S. will be like in the future and it's not a pretty picture.  Our country's current annual federal deficit of just under $1.5 trillion is equivalwent to approximately 10% of GDP.  It hasn't been at such a high level since FDR was in office during the Great Depression. 

Geithner and Obama keep insisting not to worry about the current deficit, that they are aware of the problem and that they will work hard to close the budget gap, but as Gross says in the following article "it is hard to comprehend exactly how that more balanced rabbit can be pulled out of Washington’s hat."

I've got to take my son to karate, so I'll leave you with Gross in his own words.  This is an excellent passage that every American should read.  Even if Gross does often talk his own book and rub a lot of people the wrong way, what he's saying makes a lot of sense.

Private sector deleveraging, reregulation and reduced consumption all argue for a real growth rate in the U.S. that requires a government checkbook for years to come just to keep its head above the 1% required to stabilize unemployment. Five more years of those 10% of GDP deficits will quickly raise America’s debt to GDP level to over 100%, a level that the rating services – and more importantly the markets – recognize as a point of no return. At 100% debt to GDP, the interest on the debt might amount to 5% or 6% of annual output alone, and it quickly compounds as the interest upon interest...

We are reaping the consequences of that long period of overconsumption and undersavings encouraged by the belief that lower and lower taxes would cure all.

The current annual deficit of $1.5 trillion does not even address the “pig in the python,” baby boomer, demographic squeeze on resources that looms straight ahead. Private think tanks such as The Blackstone Group and even studies by government agencies, such as the Congressional Budget Office, promise that Federal spending for Social Security, Medicare, and Medicaid will collectively increase by 6% of GDP over the next 20 years, leading to even larger deficits unless taxes are increased proportionately. Collectively these three programs represent an approximate $40 trillion liability that will have to be paid. If not, you can add that present value figure to the current $10 trillion deficit and reach a 300% of GDP figure – a number that resembles Latin American economies such as Argentina and Brazil over the past century.

So the rather conservative U.S. government debt ratio shown in Table 1 will likely be anything but in less than a decade’s time. The immediate question is who is going to buy all of this debt? Estimates suggest gross Treasury issuance of up to $3 trillion this calendar year and net offerings close to $2 trillion – almost four times last year’s supply. Prior to 2009, it was enough to count on the recycling of the U.S. trade/current account deficit to fund Treasury borrowing requirements. Now, however, with that amount approximating only $500 billion, it is obvious that the Chinese and other surplus nations cannot fund the deficit even if they were fully on board – which they are not. Someone else has got to write checks for up to $1.5 trillion additional Treasury notes and bonds. Well, you’ve got the banks and even individual investors to sponge up some of the excess, but a huge, difficult to estimate marginal supply will have to be bought. The concern is that this can be accomplished in only two ways – both of which have serious consequences for U.S. and global financial markets. The first and most recent development is the steepening of the U.S. Treasury yield curve and the rise of intermediate and long-term bond yields. While the Treasury can easily afford the higher interest expense in the short term, the pressure it puts on mortgage and corporate rates represents a serious threat to the fragile “greenshoots” recovery now underway. Secondly, the buyer of last resort in recent months has become the Federal Reserve, with its publically announced and near daily purchases of Treasuries and Agencies at a $400 billion annual rate. That in combination with a buy ticket for over $1 trillion of Agency mortgages has been the primary reason why capital markets – both corporate bonds and stocks – are behaving so well. But the Fed must tread carefully here. These purchases result in an expansion of the Fed’s balance sheet, which ultimately could have inflationary implications. In turn, nervous holders of dollar obligations are beginning to look for diversification in other currencies, selling Treasury bonds in the process.

The obvious solution to both dollar weakness and higher yields is to move quickly towards a more balanced budget once a sustained recovery is assured, but don’t count on the former or the latter. It is probable that trillion-dollar deficits are here to stay because any recovery is likely to reflect “new normal” GDP growth rates of 1%-2% not 3%+ as we used to have. Staying rich in this future world will require strategies that reflect this altered vision of global economic growth and delevered financial markets. Bond investors should therefore confine maturities to the front end of yield curves where continuing low yields and downside price protection is more probable. Holders of dollars should diversify their own baskets before central banks and sovereign wealth funds ultimately do the same. All investors should expect considerably lower rates of return than what they grew accustomed to only a few years ago.


6 Comments – Post Your Own

#1) On June 17, 2009 at 5:05 PM, UKIAHED (32.20) wrote:

Thanks for the post - a good read. Rec for every investor to read and consider.

Report this comment
#2) On June 17, 2009 at 5:18 PM, portefeuille (98.85) wrote:

the link

Report this comment
#3) On June 17, 2009 at 5:20 PM, alstry (< 20) wrote:

Just like Alstry has been saying......


We can no longer serve the banking system as few of us can afford to borrow or those of us that can have no use to borrow!!!

In the name of efficiency, it would be better to shut us down and sell our natural resources to the BRICs. 

If you think about it, it would be a lot more profitable for our banks to loan every Chinese family a few thousand dollars in a growing economy then take the risk on America where the default rate is skyrocketing making loans unprofitable.

In the name of economic efficiency, should we shut America down just as we did to thousands of factories across the nation and move all of our business to the BRICs who don't have much debt and much lower labor costs.

After all, few Americans can afford to borrow and consume anymore!!!!!!!  What good are we to the banks that we just bailed out???????

Report this comment
#4) On June 17, 2009 at 10:29 PM, XMFSinchiruna (26.40) wrote:

Thanks for posting this, Deej!

Report this comment
#5) On June 18, 2009 at 6:03 AM, TMFDeej (97.65) wrote:

You're welcome everyone.


Report this comment
#6) On June 20, 2009 at 11:52 AM, AdirondackFund (< 20) wrote:

Nice article.  It explains a lot of things. I bought a Tree Farm here in the Adirondacks seven years ago and sold my NYC Real Estate 4 1/2 years ago.  We call it 'the Kennedy rule' in our family.  The idea is to exit markets early, not even waiting for a top to form, in order to capture the next direction before anyone else even sees it.  It seems to work out pretty well as an investment plan or 'rule'.  I don't think I have ever heard a commentator or stock market pundit ever advise that it's actually a good idea to get out of markets early.  The perfection of owning a Tree Farm is that it is a real resource.  It doesn't particularly matter what currency is, or is not, in fashion.  Since there are no people, generally, in these Tree Farm areas, there are no local Government Services.  No Police, no Fire, really no nothing....only trees.

The next great wave will be an agrarian boom.  As the dollar falls in value, America will be stripped of it's resources in an effort to survive the onslaught of debt which has been created.  I was fortunate enough to payoff my Tree Farm when Katrina hit in New Orleans.  We were converting dead trees into chip at the time the hurricane hit and sold it to the local wood burning electric power plant, while natural gas price rises shut down those electric plants and electricity prices rose.

Investing is quite similar to playing pool.  You just have to learn how to make 4 or 5 ball combination shots to be successful.   

Report this comment

Featured Broker Partners